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Corporate Tax in the European Union: Tax Harmonisation vs Tax Competition



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Code :ITF0013

Year :
2004

Industry : General Business

Region : :Europe

Teaching Note:Not Available

Structured Assignment : Not Available

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Introduction: OnMay 1st 2004, the European Union (EU) expanded froma singlemarket comprising of 15 countries to 25 countries. The new EU members comprised of eight Central and Eastern European (CEE) countries along with Cyprus and Malta. There was substantial economic disparity between the new and the old EU member states. The CEE countries have experienced rapid growth in the newmillenniumwhile the oldermembers’ economies have stagnated; the newmembers’GDP grewby an average of 3.5%in 2003 andwas expected to grow by 4% in 2004 (Exhibit I).5 Entry into the EU provided foreign investors with the guarantee that the newmember states would have the same legal environment prevailing in the rest ofEU. These countries had skilled labour and significantly lowerwages as compared to the old members, and by reducing corporate tax rates they aimed to attract foreign direct investment into their countries. According to Ernst &Young, the average corporate tax rate for the new EU member states was 21.3%, while it was 29.4% for the old member states (Exhibit II). This form of tax competition has sparked a heated debate within the EU.Countries such as Germany and France have criticised the new members’ practice of cutting corporate tax rate to attract foreign investment and then using the EU funds provided by the old members to fund their infrastructure projects. There is a fear amongst the old member countries that lowcorporate taxes will drive investment out of their countries to the countries that offered lower taxes. Germany, France and Sweden have asked for harmonisation of tax rates setting aminimum and maximum corporate tax rate. However, the new member states along with Ireland and UK reject any such moves...

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